No FDIC in the Eurozone

Austrians, Libertarians, Gold Bugs, and Keynesians -- you wanted a gold standard and you can see one in action in the Eurozone! Each European Country has a central bank, but there is no Treasury function, and thus no ability to increase net private sector financial assets to avoid a Depression. It's as if the US kept the Fed, eliminated the Treasury, and decided that each State was on its own.

Almost key graph:

One member of the audience, though, had a really good question: what happens to the European system of sovereign guarantees of interbank lending? When those sovereign guarantees aren’t worth much any more, Euribor is likely to spike, since suddenly there’s a lot more credit risk involved in interbank lending. And there are hundreds of trillions of euros of debt contracts linked to Euribor, which could suddenly get very expensive and take control of short-term interest rates out of the hands of the ECB.

Correct, which is what happened to Lehman. It misses the mark though by not wondering about deposit insurance which cannot be credibly supplied in today's Eurozone.

That is correct -- the EU has no deposit insurance. It's almost enough to stock up on Gold.

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Zimbabwe 2.0

Funny or sad?

Why I don't like the Consumer Financial Protection Agency

The financial reform bill may or may not include a Consumer Financial Protection Agency. I hope it does not. This is because the fundamental role of finance is to make loans that get paid back, and anything that dulls or distracts from this task of credit analysis is contrary to the fundamental role of finance and should be banned.

From the New Yorker:

What’s less explicable, and more troubling, is the way all the players in this deal in effect outsourced the responsibility for their own due diligence to others. On the macro level, of course, the investors accepted as a matter of course the idea that you could package together lots of mediocre securities—as you can see from the flipbook that was put together for the deal (pp. 55-56), the actual securities in the deal were generally only BBB-rated—and create a security that was virtually guaranteed not to default. While widely shared, this was an assumption that made absolutely no sense in the case of subprime C.D.O.s. Then, instead of looking at the fundamentals of the securities themselves, they simply assumed that they could rely on the credit ratings the ratings agencies bestowed, even though those agencies’ conflicts of interest were well-known. And they also implicitly assumed that they didn’t have to scrutinize the actual securities because ACA Capital—the asset manager—had done that for them.

Read more: http://www.newyorker.com/online/blogs/jamessurowiecki/2010/04/wall-street.html#ixzz0laSxMdjH

The CFPA is to the household sector what the Ratings Agencies are to the corporate sector--elements that undermine a bank's duty and responsibility to conduct credit analysis.

Why Goldman is Innocent

ACA met, face-to-face, with Paulson. Which means ACA had the opportunity to talk to Paulson about the CDO. This makes it about ACA incompetence, and not Goldman fraud.

Cognitive Capture

I very much liked this Michael Lewis quote in an interview with Christopher Lydon:

Lewis: “The people who were responsible for orchestrating the crisis, because they’re on top and they’re in the middle of it, they’re the only ones who are sort of fluent in the language of it. I mean, who’s to question Tim Geithner, the secretary of the treasury, about this or that, because he’s the only with the information . . . even though he is clearly culpable in what happened.”

Lydon: “Not to mention Larry Summers and Bob Rubin and all the other architects of the deregulation. They’re still calling the shots in a new administration after a change of party management. It’s unreal.”

Lewis: “It is unreal, because basically all of the people you mentioned all swallowed a general view of Wall Street, which was that it was a useful and worthy master class, that these people basically knew what they were doing and should be left to do whatever they wanted to do. And they were totally wrong about that. Not only did they not know what they were doing, but the consequences of not knowing what they were doing were catastrophic for the rest of us. It was not just not useful; it was destructive. We live in a society where the people who have squandered the most wealth have been paying themselves the most, and failure has been rewarded in the most spectacular ways, and instead of saying we really should just wipe out the system and start fresh in some way, there is a sort of instinct to just tinker with what exists and not fiddle with the structure. And I don’t know if that’s going to work.

I think that's pretty accurate, and it is echoed in the "scandal" around Goldman's double dealing wrt to Magnetar.

I think the general reaction to the SEC charge against Goldman Sachs is "at last". I'm not sure how many people understand the fraud, or its importance, but just as they caught Al Capone on tax charges, I'm sure they just want GS caught on something.

To me, the bigger issue is how far the financial industry has drifted from its primary purpose: to make loans that get paid back. The pay practices at banks, where you get paid when the money goes out, not when it comes back in; securitization in general; CDS and various other "hedging" strategies; third party ratings agencies; all of them are contrary to focusing on credit risk which is the entire reason we have a banking system in the first place.

Instead of tinkering with this system around the edges, we should take a "spike on the steering wheel" approach and have a banking system that makes loans, keeps them on its books until it matures, and lives or dies by the quality of its credit assessments.

It's a boy

8 lbs 11 oz

Greece goes hyperbolic

Greek debt is "trading" at about a 450 bps spread, although "trading" is a charitable term considering there are few bids in the market. I think that some commentators do not believe in the US stock market recovery as there has been no structural reform whatsoever, and they would like to believe that the US economy cannot "move forward" until it has been fundamentally fixed. This is not true.

I do think that the fundamental issues in the Eurozone, of governance and operations, truly must be solved to avoid a sovereign debt default, and a second credit crises as more bank capital gets written down. Greece, fundamentally, needs a fiscal fill-up, and I do not believe that the Eurozone has any mechanism to allow this. Gold bugs -- here might be your Mellonist moment!

What happened in Japan?

Japan had their credit crises 25 years ago, and has been mired in a slump ever since. The best source I've found to detailing that history is Richard Koo, but he's not great. Here's a nice article with some of this views:

'With quantitative easing under the circumstances we have now, you can double and triple the liquidity in the system but there will be no takers,’ Koo says. ‘But there’ll be no harm done, and if certain parts of the political spectrum are happy as a result, then, you know, why not?’

In fact, QE never works.

For years Koo, now chief economist at the Nomura Research Institute, has been talking about the lessons to be learned from Japan’s ‘lost decade’—the years of recession that followed the bursting of the nation’s economic bubble of the late 1980s. In his book, The Holy Grail of Macroeconomics he argues that when an economy is pole-axed by crashing asset prices, companies no longer want to borrow money to invest because of the need to repair their weakened balance-sheets. If there are no borrowers in the market, monetary policy becomes ineffective—you can supply as much money as you want at close to zero-interest rates, but there won’t be any takers. Essentially, this suggests that there are two kinds of recession: a regular business-cycle recession, which can be tackled using monetary policy, and what Koo calls a balance-sheet recession, a far deeper kind of post-bubble recession like the Great Depression, that requires the use of fiscal policy.

Koo's position is that monetary policy works in asset crashes, but not in credit (balance sheet) crashes. He does not question whether monetary policy never works, and that asset crashes are simply not that damaging and easily fixed through automatic fiscal stabilizers.

‘As I indicated in my book, it’s one of those recessions that happens once every God knows how many decades, where monetary policy is largely dead in the water,’ he says. ‘I mean there are no borrowers. And if the money multiplier is zero negative, what can monetary policy do? Those people in the financial sector in Japan are fully aware of this difficulty. But politicians, academics and media who are never faced with the real situation only remember what they are taught in universities, where neoclassical economics always assumes there are plenty of borrowers. They tend to bash the Bank of Japan for not doing more.

There is no money multiplier. Ever. Balance sheet recessions merely reveal what is always the case.

But when it comes to the issue of Japan’s national debt, Koo flatly rejects the notion that it presents any kind of financing problem.

‘At the moment, with long bond yields at 1.36 percent on the 10-year JGB, all these arguments that Japan has a financing problem are absolute nonsense. If the long bond yield is 14 percent like it was in 1997 then I know that this country has a horrendous financing problem. But at 1.3 or 1.4 percent, the market is saying “Please go on, we need the JGB.” A country with the lowest government bond yield having financing problems? I mean these people [who say that] really have nothing better to do.’

Japan will never have any issue servicing yen denominated debt, as it does not borrow. It has a fiat currency just like the US.

As for the notion that Japan has already used fiscal policy with little effect other than to run up the huge national debt in the first place, Koo makes the point in his book that the use of fiscal policy during a balance sheet recession is absolutely vital for propping up an economy. It’s the only effective way of boosting the money supply, since any extra liquidity pumped into the financial sector will have no takers.

It might not look as if fiscal policy helped Japan much after the bursting of its economic bubble, but the alternative would have been catastrophic, Koo says. He calculates that 1.5 quadrillion yen was wiped off Japanese assets in the wake of the bubble—that’s 3 times the size of the nation’s economy. Without fiscal stimulus, Japan’s GDP should have shrunk to between a half and a third of its size, he claims. But in fact, GDP did not fall below its bubble peak, something he describes in the book as ‘nothing less than a miracle.’

This is the key point. Did fiscal policy fail in Japan, or did it do its job, but it was simply too small? If the alternative was a dust bowl style recession, the fiscal policy was, perhaps, a modest success (although I'm sure it could have been implemented in a better way).

The question is, today, why does Japan bother to tax at all?

An alternative healthcare reform

Obama's healthcare plan requires individuals to buy insurance, requires insurance companies to accept all customers, and subsidizes those who cannot afford to buy insurance themselves. Public funding and private provisioning can be a good idea, but the flaws with Obamacare have been well documented elsewhere.

I am not interested in libertarian healthcare approaches that leave people to die, nor am I interest in nationalized services either.

The most interested alternative came from Warren Mosler -- here it is in a nutshell:

1. Every year, everyone gets $5000 from the Fed.
2. The first $1000 is to be used on preventative care. It's use it or lose it money.
3. The next $4000 can be used on healthcare or not. If you don't use it all up, you keep the balance.
4. If you use it all up, and need more healthcare, medicare kicks in.

The question most interesting to me is: what will this do to prices (both generally, and in healthcare). Generally, printing money they way this plan does creates an inflationary bias. But, if healthcare is riddled with all the inefficiency from private insurance claimed by the left, and inefficiency in delivery claimed by the right, then this should get market forces acting to reduce costs and improve service as consumers exercise their choices and produce Good Deflation. Very interesting.